Monetary measures can be effectively used to control the liquidity to regulate the demand. While supply is the core of the problem, there is not much that can be done to in-crease supply in the short term, whereas demand can be directed easily to keep the inflation in the desired range.
An increase in the price leads to price-wage inflationary spiral. A monetary squeeze can stabilize price level and hence the wage. With the lack of a well developed bond market in India, bonds issued by the central bank squeezes money significantly. Further, rise in interest rate not only makes the borrowing costly but also encourages saving and reduces consumption. The recent increase in CRR will eventually bring down the amount available with banks for lending. Moreover, any monetary measure adopted by RBI signals the market about the intention of government and thus checks the price rise. Though restricting credit-availability impacts growth, inflation needs to be curtailed for the survival of the poor.
Therefore, managing liquidity would continue to take priority to push inflation back to around 5.5 percent this fiscal year.
- Kumar Saurav
AGAINST
Although Inflation is a monetary phenomenon and hence monetary policy is most logical tool to correct it; there are various limitations on the effective working of the quantitative measures of credit control adopted by the Central banks which weaken the monetary policy. Moderate monetary measures are relatively ineffective in controlling inflation and drastic monetary measures are not good because they turn economy into a tailspin. More-over, very often monetary policy is so mildly applied that it hardly has any impact on inflation.
In a developing economy like India, there is always an in-creasing need for credit to fuel the growth. However, there is a need to contract credit to curb inflation. Therefore, this conflict leads to dampening of growth if Central Bank resorts to credit control to check inflation.
Also in modern economies, securities, bonds etc. which are known as near money; represent tangible wealth. As they are highly liquid and are very close to being money, they increase the general liquidity of the economy. Therefore, it is not so simple to control the rate of spending merely by controlling the quantity of money.
Thus, there is no immediate; and direct relationship between money supply and the price level.
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